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Real Retiree Health Promise

Coca-Cola is breaking new ground by using a captive insurance company and a trust to finance post-retirement health benefits.

The Coca-Cola Co. plans to improve the healthcare coverage it provides for its retirees and their dependents, while also improving its bottom line, with an innovative financing arrangement involving a trust and a captive insurance company. Since 2000, when the U.S. Department of Labor gave Columbia Energy the go-ahead to use a captive insurer to reinsure the long-term disability benefits provided to employees, about 20 companies have won approval to provide ERISA-regulated employee benefits via a captive. But to date, companies have only used captives for group term life or long-term disability benefits.

"This is cutting-edge," says Nancy Gray, regional managing director for the Americas at insurance brokerage Aon. "There's increasing momentum in this area, but this is the first one that has been done for retiree medical."

Coke plans to take an existing voluntary employee beneficiary association (VEBA), a tax-advantaged trust that it set up to fund post-retirement health benefits, and have it buy a medical stop-loss policy from Prudential. According to a Department of Labor notice published in the Federal Register on Dec. 22, the policy would cover all medical claims for about 4,000 retirees and their dependents for their lifetimes.

The stop-loss policy coverage would start at $100 and go to an upper limit of $5,900 for those under 65 and $3,500 for those 65 and over, according to the notice in the Federal Register, which says the Coca-Cola VEBA will pay about $185.3 million for the lifetime coverage within those limits.

Prudential would then reinsure 100% of the risks under the medical stop-loss policy with Red Re, a captive insurance company that Coke established in 2006 in South Carolina.

While the Department of Labor approved Coke's proposal in December, the company said in an emailed statement that it is waiting to get a private-letter ruling from the Internal Revenue Service before implementing the program.

"The plan falls in line with our global strategy of how we manage risk at the Coca-Cola Company," the statement continues. "We see a value both for our associates and the company's own business needs."

Mitchell Cole, a senior consultant at Towers Watson, which worked with Coca-Cola on the captive proposal, says the concept of a captive can be summed up as: "It's cheaper to make than to buy."

Cole explains: "Essentially, they're making their own stop-loss medical insurance vs. buying it commercially. They've used captives for other employee benefit purposes and there was this financial logic that said since they were using it for other employee benefit financing, they should centralize it." Prudential's involvement as the provider of the stop-loss coverage fulfills the Labor Department's requirement that a commercially rated insurance company stand behind a company's benefits commitment.

Aon's Gray notes that among other benefits, the addition of the retiree healthcare coverage should help Coke control the volatility in its captive's book of business.

"There are also the potential tax benefits," she says. "Employee benefits are considered third-party risk, and if you have enough third-party risk in a captive, you are treated as an insurance company and you can take the deduction for the loss reserves."

Gray adds that because of the regulations governing VEBAs, once Coke funded the VEBA, it had no further access to the assets it had placed in the trust. Once Prudential pays Coke's captive to provide the reinsurance, the company again has access to the assets, which Gray describes as another plus of this plan.

In exchange for allowing companies to use a captive insurance company, the Department of Labor requires that the companies enhance the benefit they provide. In this case, Coca-Cola had previously reserved the right to reduce or terminate its post-retirement health care benefits, so the enhancement is the lifetime coverage provided by the stop-loss policies.

"Employees who are participating in the program will not have any revocation of future benefits," says Towers Watson's Cole. "This is security for retirees in times that are highly insecure for them. There's no question that retirees today have a lot of insecurity, involving available funds for post-retirement medical as well as their ability to meet day-to-day expenses. Coca-Cola took the initiative to secure these benefits in a way which would be explicit and support their intention and ambition to meet their retiree medical costs as they had promised."

Coke's innovation is likely to be imitated by other companies. "Now that the path has been laid in the U.S., we expect to see more companies doing the same," says Kathleen Waslov, another senior consultant at Towers Watson. "This gives companies the option to have a cost-effective way of making a promise of future benefits."

Certainly the costs of providing retiree healthcare have become a concern, one that is causing companies to back away from such benefits. A recent survey by the Kaiser Family Foundation showed just 29% of U.S. companies with more than 200 workers provided post-retirement health benefits last year, down from 38% in 2003 and 66% in 1988.

And to the extent that companies do provide post-retirement health benefits, they are largely unfunded. (There is no requirement to pre-fund such benefits, as there is with pension plans.) A Standard & Poor's study shows that in 2008, the 293 S&P 500 companies that offered such benefits faced future obligations of $322.9 billion, but had set aside just $65.7 billion in assets to fund those obligations, a 20.3% funding rate.

Many employers have already set up VEBAs, says Aon's Gray, so using a captive "might reduce the cost and provide a financial way for companies to handle the funding of retiree medical."

Cole says the advantages of using a captive aren't enough to cause companies to maintain retiree healthcare benefits. "But if it is important to maintain the benefit, then this may be a useful way to reduce the cost of financing it," he says.

The Labor Department's sign-off came a full year after Coca-Cola submitted its captive proposal, in December 2008. But once the Labor Department has approved two similar captive arrangements, subsequent applications are eligible for an expedited approval process, cutting the time required down to roughly 75 days.

"The most important thing about Coca-Cola is, it's just going to be a new area of growth for captives," Gray says. "It will allow companies to expand the use to a line of business that hasn't traditionally been insured in a captive insurance company, at least in the U.S." She says companies might consider using a captive arrangement for pension obligations as well.

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